TFSA limit put at $5,500 for 2014

Last week, the Canada Revenue Agency announced that the TFSA contribution limit will remain at $5,500 for 2014. The annual contribution limit, which started at $5,000 when the TFSA was first introduced in 2009, is indexed to inflation but is rounded to the nearest $500, leaving the 2014 contribution limit the same as it was in 2013 due to low inflation over the past year.

Of course, there is no deadline for making a TFSA contribution.

If you have been over age 18 and resident in Canada since at least 2009, beginning Jan. 1, 2014, you can contribute up to $31,000 to a TFSA if you haven’t previously contributed.

In a nutshell, TFSAs operate like RRSPs, but in reverse. Both plans allow you to earn tax-free investment income on the net contribution but with an RRSP, you are able to shelter some of your current income from tax and pay tax later when the funds are withdrawn from the RRSP or its successor, a RRIF or registered annuity.

With a TFSA, you pay tax up front on your earnings and contribute the after-tax amount to the TFSA. When the funds are ultimately withdrawn, there is no additional tax and the entire amount built up in the TFSA can come out tax-free.

If you have the money, ideally you would maximize your contributions to both plans; however, given limited funds, often the deciding factor will be your marginal tax rate today versus your expected marginal tax rate upon accessing the funds. For example, if your marginal tax rate today is high because you are working and earning a wage and when you retire it’s expected to drop, then you would maximize your RRSP contributions before contributing to a TFSA and vice versa.

The nice thing about the TFSA, however, is that unlike the RRSP, if you withdraw funds from a TFSA, an equivalent amount of TFSA contribution room will be reinstated in the following calendar year.

But be forewarned because if you withdraw funds from a TFSA and then re-contribute in the same calendar year without having the necessary contribution room, overcontribution penalties could be levied as many Canadians continue to learn each year. If you want to move your TFSA from one financial institution to another, be sure it’s done by way of a direct transfer, rather than as a withdrawal and subsequent contribution.

One tip for those who may need to draw on their TFSA funds in early 2014: consider withdrawing the funds by December 31, 2013, so you won’t have to wait until 2015 to recontribute that amount, assuming you have no excess TFSA contribution room available.